Company: Iron Mountain Author: Peter Stein Contact: email@example.com
This report examines an investment Iron Mountain(IRM).
IRM is the largest provider of physical information management (19% market share), helping clients remain within their compliance, litigation, and regulatory requirements. Storage revenue ($1.584B) is contractual and based on the amount of square feet of storage used. Service revenue ($1.339B) is either driven by account termination or from clients accessing information from IRM. IRM recently sold its digital storage division to focus on its physical business. IRM also re-appointed long-time CEO Richard Reese, and IRM’s management began a plan to return $2.2B to shareholders by 2013. Management also agreed with activist investors that a REIT conversion should be revisited.
Is IRM a Good Company?
IRM makes money by providing better and cheaper physical information management than companies could do in-house. Growing multinational firms use IRM because IRM’s international scale allows them to keep their information storage processes consistent in any location. Demand is inelastic because IRM provides critical services for a small portion of clients’ budgets.
Large PPE and tracking system costs provide a barrier to entry through economies of scale. Customer captivity is conceived by the contractual nature of the business, with termination fees recouping about 1.25x the capital investment needed to house the client’s information. More than 95% of Fortune 1000 companies contract with IRM, which may create the “IBM Effect”. This effect occurs when a company’s management outsources to an industry leader so those managers cannot be blamed if something goes wrong.
Management plans to return $2.2B to shareholders from 2010 to 2013 which may force IRM to increase its debt/EBITDA of ~3.5x toward its covenant limits of 5.5x to avoid liquidity strains. Management has a speckled track record of achieving their plans, and their alignment with shareholders varies. The capital allocation of management has been poor, resulting in a five-year average ROE of 8.5%.
Growth investments in an international division (27% of assets) and a digital storage division (sold in early 2011) have not shown the performance profile of the North American division, which currently contributes 75% of revenues and 94% of EBIT. Of the 8.5% ROE, the average contribution from leverage was 3.4x, while net margins averaged 5.4%. This does not leave much room for error in an industry that’s becoming increasingly turbulent. With the rise of the digital industry, IRM has had its competitive advantages largely eroded, and because of this and issues with management, I do not think IRM is a good business.
What is IRM’s Competitive Position?
While IRM is dominant in physical information storage, there is pressure from the digital side of the industry, especially since amendments to FRCP Rule 26 made digital information legally satisfactory in court. Even worse, IRM may lose a significant number of clients as reputable, multinational firms such as Dell and Amazon offer better digital storage services at lower prices.
Since a majority of IRM’s accounts are small volume, high margin, one year contracts, a large outflow of these clients upon contract expiry would depress IRM’s margins. Because the digital industry has even greater operating leverage, the incentive to decrease prices to fill capacity is even greater, putting further price pressure on the physical industry. IRM’s competitive position has been significantly weakened by the advent of the digital storage industry, and I believe this will continue.
Investment Thesis and Opinion
IRM’s business faces significant challenges. Currently management has a plan to return $2.2B to shareholders by 2013, $1.2B of that by mid-2012, with 2011F FCF at ~$150M, and 2011 Q3 cash of $481M. Eventually management will reach their 5.5x debt/EBITDA credit limit and will no longer be able to issue debt to pay out shareholders, a practice which has already begun. This means that management may have trouble completing the plan, or may complete it by pushing IRM into distress, or both. Payouts to shareholders from the plan and regular dividends are worth a PV of $2,183B, while the current market price is $5.6B.
IRM competes with an increasingly strong digital industry and needs many things to go right to even complete the plan, let alone grow its earnings to make its current price a reasonable multiple. Therefore, I believe IRM is largely overvalued and an investment would not provide safety of principle and satisfactory return, and because of this I would not invest.
Action Item: I always advocate doing your own research, and please do. In the current situation I will not invest in IRM.
Footnotes: Any views expressed herein are provided for information purposes only and should not be construed in any way as an offer, an endorsement, or inducement to invest. Before seeking any advisor's services or making an investment, investors must read and examine thoroughly the respective disclosure document or offering memorandum.